Michelle Singletary: IRS decision means tax-refund loans will be harder to make
Thursday, August 12, 2010
The Internal Revenue Service has dealt a hard blow to a tax product that has long needed to be knocked out.
The IRS announced recently that starting with next year's tax filing season it will not provide tax preparers and financial institutions with important debt information on taxpayers that allows the companies to arrange or make refund-anticipation loans, or RALs.
A RAL is a short-term loan backed by a tax refund. The loan lasts only until a person's refund arrives, which can be in about 10 days with electronic filing and direct deposit.
Since the 1990s, the IRS has provided to tax preparers and associated financial companies a "debt indicator" as a way to determine how much of a person's tax refund might be taken by the government.
As part of the RAL process, firms electronically submit a client's tax return and then receive an indication of whether the person will have any portion of his or her refund taken to satisfy a delinquent tax or other debt, such as unpaid child support or federally funded student loans. The debt indicator is key in the underwriting of RALs, a security that the refund will in fact cover the loan. Without the debt indicator, the bank faces greater risk that the loan won't be paid back.
IRS Commissioner Doug Shulman said the IRS provided the debt indicator as a way to get more people to file electronically.
"Back in the day, the preparers would say, 'We can set up the bank accounts if you give us the debt indicators,' " Shulman said.
However, there is now little need to provide information that helps lenders make RALs. More than 95 million tax returns have been filed electronically this year, representing more than 70 percent of all returns. With the IRS able to get electronic filers their refunds in a few days via direct deposit, there's no need to provide debt information to tax preparers, Shulman said.
"The RAL has not been a product the IRS has officially had a position on, but it's not a product I've been enamored by," Shulman said.
This is a clever move by Shulman. The decision will significantly affect the RAL business without the IRS having to ban RALs outright. For several years, consumer advocates have pleaded with the IRS to prohibit RALs because they target low- to moderate-income folks, who need every penny of their refund. The consumer groups object to the hefty fees associated with refund-anticipation loans. Through the end of June, 82 percent of RAL recipients in 2010 -- based on 2009 tax returns -- had adjusted gross incomes of $35,000 or less, according to the IRS. In 2008, 8.4 million American taxpayers paid $738 million in RAL fees, plus $68 million more in add-on fees, according to a report by the Consumer Federation of America and the National Consumer Law Center. Fees range from $34 to $130. That may not seem like a lot of money, but when RAL-
associated fees are converted into an annual percentage rate, it can amount to rates of 50 percent to almost 500 percent.
"We are pleased that IRS has decided to stop aiding and abetting high-cost RALs that siphon off hundreds of millions in taxpayers' hard-earned money and federal benefits meant to lift the working poor out of poverty," said Chi Chi Wu, an attorney with the National Consumer Law Center.